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Can I Do a Short Sale if I Have a Reverse Mortgage?

- Thursday, February 28, 2013

With so many homes underwater on their mortgages these days, some people are asking us: Can I do a short sale if I have a reverse mortgage? Before looking at that question, though, it is important to figure out whether there is even any point in doing a short sale if you have a reverse mortgage. To get to that, it is important to understand what a reverse mortgage is, and how it works.

Reverse mortgages are designed to help seniors use the equity in their home to free up cash. It is a product that is only available to homeowners who are over 62 years old: it is basically a loan drawn against the equity that they have in the home. That loan can be paid to the homeowners as a lump sum, or it can work as a line of credit, or it can be some combination of the two.

The cash amount of the total loan is recorded as a lien for that amount against the property - even if the total amount of that loan has not been disbursed.

For example, a reverse mortgage for $150,000 may be disbursed as a $100,000 lump sum to the borrowers, with the remaining $50,000 available as a Line of Credit. If the homeowners ended up using $20,000 of the Line of Credit funds, the lien on the property would still be for $150,000 (the lending limit) but the payoff of the loan would only be the amount of funds used: the $120,000 (plus interest).

In a reverse mortgage, the borrower is under no obligation to make any payments: the loan balance grows with time. The aim of a reverse mortgage is to free cash up for seniors who intend to stay in their home for as long as they are able to care for themselves. The loan comes due only upon one of the following:
  • the borrower dies
  • the borrower fails to stay current on taxes or insurance
  • the borrower moves out of the house for more than 12 months.

When a reverse mortgage comes due, the borrower (or heirs to the estate) may either refinance the home and keep it, sell the home and cash out any equity, or turn the home over to the lender. (Note, however, that the first two options are not available if the home is underwater, because there is no equity).

So what happens when property prices fall, and a reverse mortgage ends up underwater?

If the borrower is living in the home and wants to continue living in the home: If the borrower is living in the home, there is good news. All reverse mortgages are non-recourse loans - so you cannot end up owing your lender any more than what you borrowed. The lender must honor the mortgage contract, and the borrower may continue living in the home for life, or until the loan comes due (for one of the three reasons listed above).

If the borrower is living in the home, but wants to sell it: If the home is underwater, the only way to sell it is by getting the lender’s permission for a short sale. However, an advantage to doing a short sale on a reverse mortgage, compared to on a conventional mortgage, is that the lender usually will not require it to be an arm’s length transaction. This requirement is dropped for reverse mortgages because it is common that someone within the family may want to purchase the family home from the borrowers.

If the borrower has passed away: If the home has passed on to heirs, but there is no equity in the home (i.e. it is underwater) then there is no value being passed on to the heirs. However, the good news is that the heirs are not responsible for the negative equity: that is entirely the bank’s problem. While the heirs could, theoretically, work with the lender to negotiate a short sale, there is no reason for them to do that: they are not going to get the property in the end, and they are not going to see any cash from it. The only realistic option for them is to turn the home over to the lender.

In summary:

The borrower of a reverse-mortgaged home that is underwater is in a good position with choices: Their lender is required to adhere to the terms of the reverse mortgage, even if the home value has dropped. They may continue to occupy the home for the rest of their life, or until they choose to move out. They also have the option of working with their lender to negotiate a short sale, whether to a family member or to a third party, if they choose to.

Heirs who have inherited a reverse-mortgaged home that is underwater have essentially inherited nothing. The bad news is that they won’t be able to keep the home. However, the good news is that they have not inherited the debt associated with the home, either: that negative equity is the lender’s problem. The best move for the heirs is to sign the home over to the lender.

Seattle Short Sales has a team of experienced and successful real estate specialists dedicated to working with distressed homeowners. We close, on average, 12% of all short sales per month in King County. In the last 24 months, we have negotiated over 756 short sale approvals, and discounted over $81 million of mortgage debt for distressed homeowners.

In addition to our short sales negotiators, our team includes dedicated professionals advising and advocating for homeowners in the fields of: loan modifications, bankruptcy, debt settlement and collection defense. As part of our service, we offer unlimited attorney and CPA consultations.

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